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Understanding the Stock Market|How The Stock Market Works.
Basic knowledge of share market operation
Understanding the nitty-gritty of stock market
It needs no mention that understanding the stock market is the prime necessity if you are thinking of moving on to equity bandwagon as a first-time investor. Make sure that as a beginner you have the knowledge of stock market basics and you know the nitty-gritty of how the stock market works before going for actual investing in stocks. The fundamentals of the stock market operation, the trading methods and mechanics, may initially seem to be a bit puzzling for the first timers. However, armed with the basic knowledge of share market operation an uninitiated can easily overcome his usual uneasiness about the professional terms and methods used in stock trading.
The basic question that comes in the minds of the beginners is that how the stock market works. Educating yourself about the technicalities of functioning of the market will pay its own dividend as you start understanding the stock market mechanism and its techniques of making profitable trades by correctly timing purchase and sell of stocks.
Understanding the basics of stock market operation
The share market is like a tool that creates wealth for investors. It is a bid and auction market, where the price of particular scrip at any point is driven by demand and supply. As more people buy a stock its price goes up and as more people want to sell it the price goes down.It is a free market where nobody can influence the prices of the stocks. While the stock market terms like equity shares, debentures, preference shares, bonus and rights may sound like technical jargon, their meaning and investment functions can be easily mastered by the first timers by acquiring basic knowledge of share market operation. Here are few basics which are important for understanding the stock market from the point of investing in stocks.
In the stock exchange there is a two way action – the bidders compete with each other to purchase shares at the lowest possible price. Simultaneously, those seeking to sell compete with each other to get the highest price for the shares they are offering. When the buyer and the seller agree on a figure a transaction is made. Before I go into other basics of stock market let me define two most frequently used stock market terms, brokers and jobbers which are crucial for understanding the stock market properly. A stock exchange is a market for dealing in securities. However, the investing public is not permitted to enter the trading floor to do business. The investor must, therefore, employ the services of a registered stockbroker for buying or selling shares in a stock market. However, the brokers merely act as agents for their clients and deal with another class of stock exchange professionals known as jobbers. A client gives instructions to buy or sell to his broker, while the broker executes the order on the floor of the exchange through the jobber.
Understanding the stock market-how the stock market works?
Understanding the stock market and how it works is not at all difficult for the beginners. To start with, one of the most important things is to select a registered stock broker or open a D-mat account with a broking agency that will carryout the transactions on your behalf and complete all the formalities. The rest of the procedure may run as follows:
You have two options when instructing your broker to transact business,
a. You may tell him to buy or sell a scrip at a best ‘fixed rate’ and leave the matter to his judgement or,
b. You may specify reasonable price limits.
However, many times in case of price limits, the broker may not be able to execute the order as the share may not be traded in the specified limits. Too strict adherence to limits can result in an opportunity being missed, especially when the market is changing rapidly. Therefore, in a bull market it is advisable to avoid strict buying limits if you want to ensure a purchase, otherwise you could be trailing a share for days together without buying it. Similarly in a bear market it is wise to place selling orders at ‘market rates’. If you stick to a selling limit and the market plunges, you may lose an opportunity to sell your scrip that day. The next day, the price could be lower still.
Understanding the stock market-how to select scrip worthy of investment?
On the question of stock investment the most important knowledge beginners need to have about share market is how to select scrip worthy of investment. The strategy is to pick out scrips for investment which have growth potential but are yet to get focus of the investors and are, therefore, under-priced. Therefore, going back to the share market basics the first step for stock investing is to identify an industry or industries with growth potential and to study the fundamentals of different scrip under that ‘industry-group’. The main factors which influence the pricing of a scrip under a particular industry group are its cash earning per share, net earning per share, gross profit margin, book value and its price earning ratio (P/E) compared to the composite P/E ratio of that industry-group, highest and lowest price of the scrip during the last one year and the quarterly and half yearly results. While a low P/E ratio of a scrip as compared to the industry-group’s composite P/E ratio may be the easiest technique for selecting a scrip worthy for investment, this may not be always enough to base your investment decision. Other factors play a part as well. Sometimes it is observed that a company despite having a low P/E ratio and sound management with growing curve did not achieve expected price appreciation as it was yet to catch the market’s attention. Going by the share market basics such scrip should prove a good buy, provided you are patient enough. If you are really interested in making a killing by investing in shares, pick up the shares of a particular industry which is not doing well right now but has potential to turn the corner in a year or two. The crucial factor here is the identification and buying such scrip in their infancy for which it is essential to study the equity indices of various industries. If the equity index of an industry has either risen marginally or has remained stagnant or even declined, despite a growing trend in the market, it should be further investigated for investment consideration. Chances are you would get shares of companies in that industry at the lowest possible level. When it turns the corner, you can make a kill!
Understanding the stock market- timing the purchase and sale of shares
Understanding the stock market fundamentals is essential for a first timer when it comes to acquiring the crucial knowledge about - how to decide when to buy the shares. While a study of the fundamentals can tell you the intrinsic strength of a company or industry, it can not convey the right time to buy its shares. For this you have to take the help of equity indices and price earning ratio. Of course, going by the basics of share market there are a few ground rules in this regard. Investors should never enter the market in the middle of a bull phase. Once this phase has ended and the market has stabilized, start watching the movement of various equity indices from financial news papers. If you find minor ups and downs in the movement following the stabilized period, you can safely assume that there will be no further fall. This is when the investors start accumulating shares in small lots and various indices start rising. When the indices have risen by a convincing margin of 10 percent on an average, if you want to strike while the iron is hot, that is the ideal time to buy.
Tips for beginners on how to invest in stocks
Stock investing is not as complicated as it sounds. Here are a few tips for beginners on how to invest in stocks, knowledge of which will stand the first time investors in the share market in a good stead:
- Buy when others are selling and sell when others are buying. In short, go against the crowd;
- Sell at least 50 percent of your holding if the appreciation has been over 100 percent;
- Sell when the market has turned extremely volatile;
- Never back a weak horse. Never take a long position on weak scrip or a short position on a strong one;
Of course, aside from fundamentals and technical analysis, the instinct of the investor also counts in deciding the ideal time of purchase and sale. However, this is not possible for beginners. For this it requires understanding the stock market thoroughly with years of practical knowledge about share market investment. My other hub about how to make money in the stock market shows how ‘timing’ of purchase and sale plays a crucial role in making quick money from stock investment.
In a nutshell, investing in share market is not as complicated for the first timers as it sounds once they acquire the basic knowledge of how the stock market works. Understanding the stock market fundamentals and the essentials of investment in stocks discussed in this post, would eventually bring the process of buying and selling of shares within a methodical framework and it will take little or no time for you to know the ropes of the equity world about how to invest in stocks.